The latest research from the Credit Suisse equities team outlines 21 stocks which are set to become market favourites.
While many investors have their own preferred stocks, the reasons for favouring one company over another are many and varied.
So analysts Hasan Tevfik and Peter Liu undertook some quantiative analysis to create a benchmark for what constitutes a “market darling”.
It allowed them to apply their criteria against stock prices all the way back to the mid-1990’s, thus providing some historical context.
However, the analysts noted that by the time a stock becomes a market darling, it’s often too late to buy in.
As Tevfik succinctly points out, “the time to dance with a darling is before they reach darlinghood, not after”.
“Successful investors can spot beauty before everyone else does.”
So with that in mind, the table below lists 21 stocks on the ASX200 which Tevfik and Liu said are well-placed to become future market darlings.
It includes eight stocks from the financials sector — but none of the big four banks — and 13 non-financials across multiple sectors:
As part of their research, the two analysts outlined three key characteristics of a future market darling.
1. Large profit margins: As the above table shows, two thirds of stocks on the list have a profit margin on their earnings before interest, tax, depreciation and amortisation (EBITDA) of more than 20%. The remaining third has an EBITDA margin of more than 40%.
2. Strong balance sheets: More than 20% of the companies have more cash than debt, and almost half have a net debt to EBITDA ratio of less than 1x. Net debt is the total value of a company’s cash and liquid assets, less the sum of all liabilities and debt.
3. Strong growth: Most stocks on the list have moved past the development stage and are currently in the steepest part of their growth curve.
The research also includes a list comprised of eight stocks which are the current “market darlings” on the ASX200 as at October 2017:
Only one stock on the list of current “darlings” — Aristocrat Leisure — made the cut-off for the 21 stocks listed above which are poised for future growth.
The above group of stocks currently trade on a combined price-to-earnings (PE) multiple of 29 times, which is down from a multiple of 38 times 12 months ago.
“Despite the de-rating, Aussie darlings still trade at a premium to their own history and a higher than normal premium when compared to the rest of the market,” the pair said.
Tevfik and Liu’s metric for calculating their list of current market darlings is based on stock-returns and earnings data compiled over the previous 18 months, as follows:
1. Best risk adjusted returns over the last 18 months
2. Most number of months, in the last 18, with positive total returns; and
3. The highest 12 month forward-looking PE multiple the last 18 months.
Recall though, that once a stock becomes a darling, it may be a sign that near-term capital growth is about to slow.
Tevfik and Liu noted that stocks which met the “market darling” criteria two years ago had failed to outperform the broader market since then.
To demonstrate their point, this chart clearly shows the shift in the growth path of stocks once they become a favourite among investors: